Just when you were wondering if the banking sector could come up with any more surprises, along comes the LIBOR scandal: an admission that a group of major banks had been manipulating an interbank lending rate for their own gain – and consequently making borrowing more expensive for the rest of us. It was manipulation of a key instrument at the core of the financial system that made Bernie Madoff look like a weekend player in comparison.
Bob Diamond, Barclays’ now former chief executive, was quick to regret that, "the impression has been given that the behaviour revealed... is indicative of the culture at Barclays generally.” It seems that, as ever when a scandal breaks, bankers are quick to point the finger at some rogue trader to explain it away.
Yet this is just the latest in a long series of banking crashes and scandals, adding to the names of Barings, Savings and Loans, Enron, Société Generale, and, more recently, JPMorgan, which is still unable to tell us how much it has lost ($2bn, maybe $4bn or more. Who knows?). In fact the only striking thing about these events now is just how regularly they come along.
Time to address the banking culture, Tim
But when bad luck strikes so often in a particular sector, can it really just be bad luck, or is it indicative of something more profound? As Goldfinger puts it in the eponymous James Bond novel, “Once is happenstance. Twice is coincidence. Three times, it’s enemy action.” And while working on our upcoming book on strategic surprises at the CIA, we ended up agreeing with the sociologist Max Weber that any regular pattern of behavior must be understood in terms of its cultural setting.
So what is the cultural setting of a bank? In essence, modern day banking is a culture of “perverse incentives” (aka reasons for cheating). Protected by the ‘too big to fail’ guaranty, bankers trade knowing full well that if things go wrong, taxpayers will come to the rescue and pay the bills. If things go well they will pocket handsome profits. And whatever happens, humongous bonuses will still be there to sweeten everything. It is the same ‘agent-principle’ problem that any large business has, but in this case it is on steroids. Add to that the fact that banking today essentially amounts to borrowing zero percent interest money from the state and lending it on at five percent, and who can seriously deny that it’s all about using an unfair advantage? Worse still, as Nassim Taleb, author of ‘The Black Swan’, has demonstrated, bankers play with financial instruments they don’t understand and such instruments are based on flawed hypotheses about risk and uncertainty.
At the highest level, bankers wittingly sell hazardous products they can know nothing about. Which is like having a nuclear missile division run by entertainment executives. Nobody would do that in real life, but it’s just the way it is in finance. Don’t take it from us: Warren Buffett called derivatives “financial weapons of mass destruction”... Crashes are no accident. They are systemic. They are inherent. It’s the culture. It’s enemy action, only bankers have discovered that the enemy is themselves.
Brace yourselves for the next banking crash – it’s coming soon.
